During the real estate boom, commercial real estate borrowers opted for three and five-year balloon mortgages rather than safer long-term loans. Instead of choosing 10-year, 20-year or even longer terms, they decided to get a lower interest rate and hike their leverage.
But in hindsight they made the wrong decision because the short-term loans are coming due and refinancing options are very limited. That is because credit markets have deteriorated since the original loans were made. While 80 and 90-percent loan-to-value mortgages were available before the crunch, 60 to 70-percent is more probable today. Additionally, higher cash flow ratios, stronger balance sheets and higher, personal credit-scores are needed.
Even if borrowers can meet the new underwriting standards, property values have nosedived restricting loan amounts further. Hotel values, for example, have plunged 40 percent, according to Bob Coleman, founder of Coleman Publishing and a former business lender.
But he also notes, "With the increase in 504 loans to $5.5 million, today's SBA lender can easily finance a $10 million plus project." Coleman is referring to the U.S. Small Business Administration's 504 program that targets commercial real estate and other fixed assets.
The program consists of two loans, a bank's first mortgage and SBA's subordinated debenture, which is similar to a second mortgage. The combination of the two provides highly leveraged, low-fixed-rate, long-term financing.
The government-guaranteed debenture is limited to $5.5 million or 40-percent of the project cost. The first mortgage is usually 50-percent and can go higher if the bank is willing to take more risk.
The basic program does not allow refinancing of existing debt. But under a new SBA initiative lenders are permitted to use 504 loans to refinance balloon mortgages coming due.
Eligible borrowers must meet SBA's definition of a "small business." Thus, business size is restricted by revenues, and sometimes, by the number of employees. Examples are revenues of $10 million for limited-service restaurants, $30 million for hotels and 500 employees for manufacturers.
Tallahassee, Fla.-based Florida First Capital Finance Corporation says that it closed the first 504 refinancing in Florida. It paid off two ballooning loans for Lazy Days Restaurant in Islamorada, Fla.
FFCFC is an SBA-licensed certified development company. CDCs arrange 504 loans by processing the debentures and coordinating the piggyback loans with SBA, first mortgage lenders and the borrowers.
Carlos Calero, FFCFC's vice president said that the Lazy Days funding was 90 percent of value. "We need to work backwards because we need to establish the appraised value of the property," he e-mailed me. "Once we establish the appraised value with an appraisal, the bank will finance the 50 percent," he says. Then the SBA debenture will fund the difference so that the total financing is "a max of 90 percent of the appraised value."
Job-creation is not necessary as it is with basic 504 loans but other property requirements apply. Therefore passive, non-owner-operated investment real estate such as multi-tenant shopping centers and office buildings, and tenant operated retail stores, are disqualified.
The 504 refinancing initiative is not a rescue program for delinquent loans or businesses with negative cash flow. In fact, historic mortgage payment data and operating statements are scrutinized as part of the underwriting process.
According to Calero, FFCFC requires the business's cash flow to be 20-percent greater than the loan payments, or a debt service coverage ratio of 1.20, in financial parlance. He adds that banks "are from 1.25 to 1.45," but "most of the lenders will work with projection; this will be case by case."
In other words, FFCFC has to document the cash flow projections to SBA. Then, the first mortgage lender has to buy into the numbers and the resulting loan must be acceptable to the borrower.
"We spent three weeks between us and the SBA structuring this loan," Calero says. The three weeks is in addition to approximately two months it normally takes to close the U.S. Small Business Administration's basic 504-loan.
I asked Calero if he is willing to tell me the specific details about the structuring challenges he had to overcome between SBA and the first-mortgage lender. "Sure I will," he e-mailed his willingness disclose the problems. "I am not in the office but I will send you the details."
That was May 18 and Calero has been unresponsive to my requests for details since then. Likewise, the borrower has not replied to my inquiry.
In all fairness, FFCFC is reluctant to discuss confidential information about the case and the borrower may have jumped through unpleasant hoops to get the loan closed. So neither of the parties appears willing to speak negatively about SBA's new refinancing initiative.
Despite the imperfections, SBA is filling a niche where traditional lenders fear to tread. Moreover, the program will likely become easier after SBA and the CDCs have a few deals under their belts. But until the credit markets substantially improve, 504 refinancing may be the only game in town. Accordingly all the playes have to play ball.
Jerry Chautin business columnist and SBA's 2006 national "
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Jerry
Jerry Chautin
Business columnist
Volunteer SCORE business counselor, Atlanta, Sarasota